Economic Outlook: Where austerity hurts

The Congressional Budget Office said this week new policies would pinch spending among the rich and the poor.

The double whammy comes from the end of the payroll tax cut, that adds 2 percent in deductions from the weekly paycheck and the new tax code that raises federal taxes for individuals earning more than $400,000 per year and for households that take in more than $450,000 per year.

For a struggling economy, these are painful sacrifices, with the end of the payroll tax cut alone reducing discretionary funds by $120 billion over the course of the year, The New York Times reported.

That amounts to a gross domestic product reduction of half a percentage point in the first quarter of the year, the Times said.

This is the payroll tax cut that former Treasury Secretary Timothy Geithner threw under the bus. "I don't see any reason to consider its extension," Geithner said at a government hearing.

Democrats gave up on the payroll tax cut that was a two-year gift that lasted a year longer than it might have. It was originally scheduled to end in January of 2012.

Liberals pounced on the end of the program as a regressive step, that being defined as a policy that weighs by proportion heaviest on the poor. Indeed, those earning under $25,000 per year are now out approximately $850 per year, while those earning $100,000 are out about $2,000 per year.

By the numbers, people earning $25,000 per year earn 25 percent of $100,000, yet the annual sacrifice of $850 per month comes to 42.5 percent of the sacrifice made by those earning $100,000. (The payroll tax cut had a cutoff point of $113,700 per year, so people wealthier than that were not affected one way or another.)

"If you wanted to design a policy to squeeze the spending of lower- and middle-income households, raising the payroll tax is the way to do it. It's very regressive," said Ian Shepherdson, chief economist at Pantheon Macroeconomic Advisors.

The end of the payroll tax cut, however, was not made in isolation. Federal taxes for the highest wage earners jumped from 35 percent to 39.6 percent and there is nothing regressive in that at all. In fact, that sacrifice only affects 0.4 percent of U.S. wage earners, according to the Tax Policy Center.

And yet -- hold on. Tax rates are not definitive after all. Because of the numerous loopholes, deductions and tax credits there is a second category called the effective tax rate. That's the tax rate that is the sum actually paid to the government. In effect, the effective tax rate is the advertised tax rate minus all the fine print.

There is a delay for the data available, but the IRS has released the effective tax rates from 2007, which shows the top 1 percent paying 20.6 percent in taxes and the top 5 percent paying more: 20.9 percent. The top 10 percent also paid more than the top 1 percent, paying an effective tax rate of 20.7 percent.

In 2007 the progression from the lowest wage earners to those earning $94,100 per year, the effective tax rate climbs in a linear fashion. It is only above $94,100 per year that the pattern gets derailed, as if incomes that high are so far away that some fundamental law of nature, like gravity, no longer applies.

Looking ahead, the spending cuts portion of the 2013 budget will undoubtedly include a very regressive outcome, given the point that government services are mostly designed to help those who need the help.

In international markets the Nikkei 225 index in Japan dropped 1.8 percent and the Shanghai composite index in China added 0.57 percent. The Hang Seng index in Hong Kong climbed 0.16 percent and the Sensex in India lost 0.49 percent.

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